What is money management and why is it needed?

Money management in the FOREX market

Almost every beginner trader in the FOREX market for the first time, deals exclusively with those that are looking for a trading method that allows you to make a successful transaction, minimizing the number of incorrect. It seems clear that for getting good profit we need to achieve is a positive attitude of shopping successes and failures, and this is the key to success.

The emergence of experience, beginners can understand many laws of market trading and ways to be quite reliable predictions of the behavior of prices, such as the surveillance of macroeconomic news and statistics, technical analysis and markup using the Elliot waves. Each of these methods is working perfectly and widely used by the traders who have already achieved success in the market.

Achieving a sustainable skill in determining the direction of trends, entry points and stop loss setting, the rookie continues to trade, but the Deposit melts day after day, despite quite a moderate risk and a large number of profitable trades. As the money of trader is gradually transferred to the account of the brokerage company, he has legitimate doubts in correctness of the chosen course and raises the reasonable question: how to manage finances, to make a profit instead of a loss?

What is the proper money management

Money Management (money management) – system control number currently in trading capital to optimize trading results, taking into account the dimensions of risk and reward and is based on strict mathematical calculations.

Basic misconception concerning proper money management is possible to meet very frequently, almost-every second of trading strategy from among those that propose to use for beginners. This misconception lies in the fact that traders believe the words: the basic rule of money management is to prevent the risk of order higher than 5 (4, 3, or even 1, to taste) percent of the Deposit in order to trade break-even. It’s a good rule to calm the nerves but an absolute lie.

Imagine that a risk of 5% of the total Deposit is 50 or even 100 points, and at this distance, we place the stop order. Obviously, for the loss of the entire Deposit would take 20 losing trades, then have 1 or 2 thousand points. It is very hard to fail to trade. Likely that one of the four or five of our transactions must be successful, otherwise you should just change the occupation. All true, but even at a ratio of 50 to 50, there is no guarantee that the Deposit will not be lost. The fact is that not specified the size of the profit, and it may be only 20-30 points to each winning transaction, that is, the total income will never exceed the loss. This unilateral approach, in fact, is not money management, but just specify some particular rules that seem reasonable and can sometimes be useful.

Another mistake can be called the various allegations such as the fact that for a profitable trade follows after the trades in a profit to open several more in the same direction, and continue so until then, until the end of the trend. This approach is called “pyramiding” and is little different from the creation of the infamous financial pyramids – the base of the building, too, has no Foundation.

Even more dangerous is the approach to trading using martingale principle when invited to each subsequent transaction in a series of losing access to a larger lot, so she compensated the previous losses. There are even very complicated logarithmic formula for calculating the volume of such transactions for different trading options, but so far there is no trader who would be successful using this method.

The real success formula

Proper money management needs to provide positive mathematical expectation of profit for the entire series of transactions in which it is applied. It is an axiom, and the real formula of success in the FOREX market. What does it mean?

Mathematical expectation of profit is the sum of the products of the probabilities of wins multiplied by the amount of those winnings, minus the sum of the products of the probability of losing multiplied by the amount of losses. This simple formula is the basis of proper money management, which can guarantee a successful trade even when profitable trades are much less than successful, for example, two or three times.

This ratio, incidentally, is consistent with statistics, which for many years has collected a brokerage company. According to the data, which can be found in the public domain, only 25% of all transactions on the FOREX market successful, all the others unprofitable. But for a positive Mat. expectations this is not a problem – just trade so that the profit of transactions was four times greater than the loss, and the success is guaranteed. In other words, you should not open trades, take profit which is less than four stop-loss. This is the main rule of money management, which is not very like to talk to brokers. Apparently, it’s too simple and obvious to use it.

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